Global economy faces a threatening downward spiral

The International Monetary Fund has called on the US and Europe to abandon fiscal austerity and switch to stimulus measures, warning that the global economy faces a “threatening downward spiral”.

Christine Lagarde, the IMF’s managing-director, said the outlook had darkened suddenly over the summer.

“There has been a clear crisis of confidence that has seriously aggravated the situation. Measures need to be taken to ensure that this vicious circle is broken,” she said.

“The spectrum of policies available is narrower because a lot of ammunition was used in 2009. But if governments, institutions and central banks work together, we’ll avoid recession,” she told Der Spiegel.

The UK Telegraph reports that these comments come at the start of a dramatic week for the eurozone as Italy prepares to roll over record sums of debt and Germany’s constitutional court issues its long-awaited verdict on the legality of the EU’s bail-out machinery.

Markets are already tense after the EU-IMF ‘Troika’ withdrew abruptly from Athens on Friday, accusing the Greek government of failing to comply with rescue terms.

The Italian treasury must redeem €14.6bn of debts this week and €62bn by the end of September, the most ever in a single month.

“We are experiencing very demanding times,” Jean-Claude Trichet, the European Central Bank’s president, said over the weekend. The ECB has stabilised Italy’s debt over the last four weeks, capping yields on 10-year bond yields near 5pc through purchases on the secondary market.

It is unclear how much longer the ECB can keep doing this after a string of top officials in Germany described the bank’s actions as illegal.

“The ECB cannot substitute for governments,” said Mr Trichet. He was speaking at the Ambrosetti Workshop at Lake Como, where he held a closed-door meeting to discuss the euro crisis with Bank of England Governor Sir Mervyn King.

The ECB has bought an estimated €35bn of Italian debt under an implicit accord that Rome will deliver on austerity promises.

Premier Silvio Berlusconi has come close to breaching the terms by backsliding on a wealth tax and pension reform.

Emma Marcegaglia, head of Italy’s Confindustria business lobby, said the austerity measures were “unjust, iniquitous, and inadequate”, and undermine the credibility of the country.

Leading Italian economists have begun to question whether EMU itself is workable.

“It’s clear that the euro has virtually failed over the last ten years, even if you are not supposed to say that. We pretended to be Germans, but it was an illusion,” said Professor Giacomo Vaciago from Milan’s Catholic University.

Mrs Lagarde said the US has scope to “abandon short-term austerity and introduce some measures to drive growth” provided the country lays out a credible debt strategy over the medium term.

She said Europe needs to take its foot off the fiscal brake and shift to “growth-intensive measures” until the danger has passed, insisting that Germany has leeway to “stimulate demand”.

My thoughts on this:

While we’re on the other side of the world here in Australia, we don’t live in a vacuum and obviously we’re affected by what’s happening overseas. And some commentators are suggesting there is a financial tsunami ahead and we are just feeling the first ripples.

The stronger European countries are tired of supporting the weaker countries that have not shown any financial discipline.

Clearly there is a lot of instability in the world financial markets, and it will take some time to work through these issues. Until the average Australian consumer develops more confidence, they will keep saving, rather than spending and this will put a damper on our property markets. I can’t see a reason for a major change in market sentiment for another 12 – 18 months.

Now don’t get me wrong. I’m not saying stay out of the property markets – far from it. I’ve just committed to another property development this week. What I am saying is I’m not counting on much capital growth for a while, but I’m taking advantage of countercyclical opportunities.

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Michael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and his opinions are regularly featured in the media. Visit Metropole.com.au

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